China’s New Silk Road Is Getting Muddy

The 'One Road, One Belt' initiative looks good on paper, but could become a costly mess on the ground.

With the future of U.S.-China relations an open question for the incoming Donald Trump administration, many have focused on whether the president-elect’s promise to withdraw from negotiations over the Trans-Pacific Partnership (TPP) will enhance Beijing’s growing influence in East Asia. But rather than hand-wringing over TPP’s ignominious failure, Asia watchers should turn their attention to China’s unprecedented $1 trillion strategic gambit: the Silk Road Economic Belt and the 21st-Century Maritime Silk Road, aka “One Belt, One Road” (OBOR). Launched in 2013 as President Xi Jinping’s signature initiative, OBOR holds great promise, as well as potential pitfalls, for both China and its neighbors.

OBOR is a game-changing plan to bring about the next stage of globalization, a Sinocentric vision that harks back to the ancient Silk Roads — but this time on Beijing’s terms. The goal is to create a new economic “belt” of connective infrastructure westward into Eurasia and a new maritime “road” connecting China to Southeast Asia, South Asia, the Middle East, and Africa. Examples of OBOR projects include a railway linking China to Laos and another one through Mongolia and Kazakhstan; gas and oil pipelines through Turkmenistan and Myanmar; road and port development in Sri Lanka; and the cornerstone $46 billion China-Pakistan Economic Corridor (CPEC), which encompasses highways, pipelines, coal-based electricity generation, and the Chinese-operated Gwadar port. OBOR is primarily a “build it and they will come” initiative. Rather than improving the host country’s industrial or productive capacity, it expands and strengthens transportation and energy arteries, including ports, rails, communications, electricity, and pipelines. It promises to stimulate the ailing Chinese economy in the short and medium terms through construction and telecoms contracts and capital goods provision while in the long term opening new trade routes so Chinese products can fill store shelves in OBOR countries for decades to come.

Lending to your neighbors to finance infrastructure projects that you build for them is a shrewd way to make friends while generating business for Chinese firms and earning better returns than U.S. Treasury bills. But the approach does carry significant economic and political risks for China, as well as for recipient countries and local communities. Under OBOR, China is loaning hundreds of billions of dollars to fund infrastructure construction in foreign countries during an economic slowdown at home — a recipe that could spell disaster if it fails to stimulate the Chinese economy or leaves poor countries hopelessly in hock to Beijing.

For two decades, China has promoted an increasingly expansionist “going-out” policy among its state-owned enterprises that includes strong financial and political support for construction and telecoms companies to penetrate Asian and African markets. OBOR takes this approach to a new, and far riskier, level. Beijing has set aside nearly $1 trillion to make concessionary loans to about 60 developing countries via its policy banks — principally the China Development Bank and Silk Road Fund — to underwrite the construction of approximately 900 infrastructure projects. After terms are reached with a host country, funds are transferred directly into the Beijing-based bank accounts of China’s state-owned enterprises, which build the project often with Chinese materials. This is a model Beijing has employed extensively in Africa. Once Beijing’s political blessing for a project is communicated via funding from its policy banks, China’s national- or provincial-level state-owned enterprises build it, often with little or no political or financial risk assessment or market research.

China’s sluggish domestic economy and fears of a U.S.-China trade war have increased the pressure on officials to approve OBOR projects and move them forward expeditiously. Policymakers are hoping OBOR can help mitigate falling demand and deploy excess capacity in Chinese construction firms and their suppliers. In China, it seems everyone is banking on the Silk Road revival; provincial and local officials, along with suppliers from around the region, have been attending massive Silk Road-themed product forums like the China-Eurasia Expo held in Urumqi last September. Even Maotai, China’s most famous brand of baijiu, a distilled Chinese liquor, is hoping to hitch a ride on OBOR to expand sales and international distribution networks.

The problem is due diligence. OBOR involves risking hundreds of billions of dollars on the assumption that poor countries either can or will pay China back. The lending program’s sheer size has already required the Chinese government and party organs to detail hundreds if not thousands of staff to vet scores of projects across a myriad of regulatory, linguistic, and cultural environments. This effort demands intragovernmental coordination across dozens of agencies and state-owned enterprises, many of which have little or no understanding of political or financial risk analysis. With such little experience in Beijing, much OBOR planning has been farmed out to provincial-level officials who are equally unqualified to vet the future profitability of investments in numerous uncertain political, economic, and regulatory environments. Religion is another consideration for the atheist Chinese, since OBOR traverses large swaths of the Muslim world.

OBOR represents a massive and unprecedented expansion of connected lending to international borrowers that enmeshes the already deeply indebted Chinese banking system in some of the world’s most precarious economic and political environments. Many poor countries are happy to take cheap Chinese loans now and let future leaders and citizens pay them back. Indeed, China’s existing loans to friendly governments in Zimbabwe, Venezuela, and Sri Lanka already portend tens of billions of dollars in potential losses. China’s response, especially in Africa, has often been to grant loan forgiveness and then make more loans, which has, in turn, created serious moral hazard. Many governments are banking on China’s continued largesse and are thus happy to get as much as they can while they can. Still, even Beijing, which is sitting on $3 trillion in reserves, can’t write off bad loans ad infinitum.

Another looming problem is graft. Amid Xi’s historic crackdown on corruption at home, OBOR could open new international opportunities for Chinese firms to collaborate with each other and their foreign hosts to engage in waste, fraud, and embezzlement. China, which itself ranks an unimpressive 83 on Transparency International’s 2015 corruption index, is preparing to build hundreds of projects in some of the least accountable countries in the world, such as Turkmenistan (154), Kyrgyzstan (123), Cambodia (150), and Myanmar (147).

Although most of the cash will never leave China, the sheer quantity of equipment and materials, such as steel, concrete, and timber, needed to produce so many projects will provide ample opportunity for pilferage and other types of on-site malfeasance. Indeed, Chinese firms operating in systemically corrupt business and regulatory environments may find it impossible to gain the necessary local support without greasing palms. Corruption could also come via kickbacks or bribes to loan officers from self-interested firms or officials, padding purchase orders, or cut-rate building materials. Such misconduct remains a problem in China itself, and it seems likely the weaker regulatory environments in some OBOR host countries would only exacerbate it. Xi himself seemed to recognize the problem last August when he called for a “stable, sustainable and risk-controllable financial security system” to supervise the OBOR initiative.

China’s business practices are already facing local pushback in several countries where its state-owned enterprises have built energy and infrastructure projects. Some firms have been accused of cutting corners, ignoring safety standards, using secondhand or low-quality materials and equipment, and building environmentally destructive projects, such as hydroelectric dams or coal-fired power plants. Complaints have come from Laos, Vietnam, and Cambodia regarding environmental damage and droughts from Chinese hydropower projects along the Mekong River; from Indonesia regarding an ill-fated, over-budget coal power plant and a failed high-speed rail project; and from Myanmar regarding Chinese firms clear-cutting forests.

Last month, dock workers at Hambantota port in Sri Lanka held the massive Japanese vehicle carrier Hyperion Highway and its crew hostage for several days after they were cut out of a 99-year lease agreement with the state-owned China Merchants Port Holdings Co. Meanwhile, in Venezuela’s Bolívar state rioters looted hundreds of Chinese-owned businesses including shops, supermarkets, and warehouses. In Pakistan, workers on Chinese mining and construction projects have been attacked by Baloch rebels embroiled in separatist struggles with the government. Extensive squabbling among Pakistan’s political parties, the military, and local community leaders continues to delay the implementation of numerous CPEC projects.

In response, at a rare public address last month in Islamabad, Zheng Xiaosong, the vice minister of the Chinese Communist Party’s International Department, called for Pakistan’s political parties to “work together to resolve their differences and make CPEC a success.” China has also enhanced security. Beijing will soon be deploying navy vessels to help secure Gwadar port, and the China Shipbuilding Trade Co. has turned over two new patrol boats to the Pakistan Maritime Security Agency.

But diplomatic platitudes and enhanced security alone cannot protect every OBOR project and may further embroil China in the domestic politics of its neighbors. Without on-site accountability, environmental degradation and community displacement, which have already become problems with China’s projects in Southeast Asia, are likely to fuel local resistance.

OBOR presents significant domestic economic and political risks for China. There is real tension between the Chinese government’s drive to invest in riskier developing countries via OBOR and private capital’s flight to safety amid a domestic economic slowdown and growing protectionist fears. Just as Beijing is pushing OBOR on its state-owned enterprises, private Chinese investors are finding ever more ingenious ways to offshore their resources in safer assets, particularly U.S. real estate. Beijing has responded with increasingly pervasive capital controls, but technology has made these difficult to enforce.

More than a decade ago, the United States called on China to be a “responsible stakeholder,” both in its neighborhood and beyond. The years since have seen the rise of a new, and increasingly assertive, Chinese foreign policy. OBOR is a big part of Beijing’s new approach and a potential harbinger for a new stage of Sinocentric globalization. It is a grand vision with wide-reaching political consequences both at home and abroad. If it succeeds, China will become the unquestioned Eurasian hegemon. But Beijing’s efforts likewise carry enormous economic and political risks that Chinese policymakers know they must mitigate if President Xi’s initiative is to live up to its billing. The question is whether OBOR can overcome the logistical, political, security, and financial challenges identified above — or be thwarted by them, losing hundreds of billions of dollars and creating a slew of disgruntled debtor neighbors with landscapes scarred by white-elephant projects. Only time will tell.